Litigation risk, universal demand laws, and corporate financial decisions: Evidence on debt and dividend policies

Yao, Wanru; Arif, Ahmed; Rubbaniy, Ghulame; Vendrame, Vasco

Abstract

This paper investigates how litigation risk and the adoption of Universal Demand (UD) laws affect corporate debt and dividend policies in the presence of managerial risk-taking and cash constraints. Using a sample of S&P 500 non-financial firms, we estimate litigation risk through a novel methodology based on shareholders' right-related controversy cases-drawing from the ESG Controversy Score by Thomson Reuters. Our findings, robust to various methodologies, show that UD law adoption, managerial risk-taking and cash constraints influence leverage positively, whereas litigation risk has a negative effect on leverage. However, this effect is highly industry specific as we find an overarching industry effect. While we do not observe a direct effect of litigation risk on dividends, managerial risk-taking and cash constraints both reduce dividend pay-outs. Furthermore, dividends appear to be sticky in our findings, consistent with signalling and clientele effect. We document that UD law adoption positively influences the dividend policy which is aligned with existing literature on corporate governance and shareholder protections. Overall, these findings highlight the dual role of legal protections and litigation considerations in shaping capital structure and pay out decisions thereby hampering the future growth opportunities.

• Working Paper Type: Working Paper
• Publication Date: Mar 1, 2025
• Deposit Date: Mar 5, 2025
• Publicly Available Date: Mar 6, 2025
• Keywords: Litigation Risk; Universal Demand Laws; Capital Structure; Dividend Policy; Man- agerial Risk-taking
• Public URL: https://uwe-repository.worktribe.com/output/13908185